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Updated on Monday, February 16, 2015
Earlier this month, the OCC (Office of the Comptroller of the Currency) quietly issued Bulletin 2015-13, which announced the publication of a revised handbook on deposit-related consumer credit. The OCC is getting tough on bank overdrafts, which have come under increasing scrutiny for being predatory. At MagnifyMoney, we have long called overdrafts one of the most expensive forms of short-term borrowing in the world.
The last booklet was issued in March 1990, and was used by OCC examiners to assess a bank’s deposit-related consumer credit activities, including overdrafts. The new handbook has established standards which would dramatically change the overdraft products currently offered by banks in the country. If the banks actually follow the rules outlined by the OCC, we should expect a revolution in the way products are designed, priced and marketed. However, banks are very good at making minimal change in the face of new rules, particularly when significant revenue is at stake. Banks generated an estimated $32 billion in overdraft fees during 2013, so they will not give up this revenue stream easily.
Bank overdrafts are marketed by banks as a “protection” that can help a consumer if they are running short of cash, or if they make a mistake. However, they are extremely expensive. If you do not have overdraft protection (a linked account), a bank will typically charge you $35 if they approve the transaction (an overdraft charge), or $35 if they decline the transaction (an NSF, or non-sufficient funds, fee). The fee is charged on a per incident basis, regardless of the actual transaction value. If the transaction is approved, the total amount of the overdraft (which includes the shortfall and fee) is due immediately. Many banks will charge an incremental extended overdraft fee if the account balance is not brought positive quickly. For example, it could cost $70 to borrow $6 for 6 days from Bank of America, based upon their overdraft fees and rules. In addition, even the method of posting transactions has caused controversy. Rather than posting transactions as they happen, nearly half of the banks in America re-order the transactions, posting the highest value transactions first, thereby increasing the number of times that an individual can trigger an overdraft charge.
Reg E did provide some additional consumer protection. It required banks to receive opt-in for overdrafts that are triggered by ATM cards (when withdrawing cash), and debit cards (when making purchases in a store). However, the regulation did nothing to protect all other forms of transactions, which includes checks, automatic payments, billpay and others.
Bank overdrafts in the United States raise every red flag imaginable. The incredibly arcane and complicated fee structures lack transparency and exist to extract maximum value from consumer mistakes or misfortune. The costs charged by the banks for what is effectively a line of credit are obscene when compared with the actual cost of providing those services. And, although banks like to point fingers at payday lenders and focus on their CRA activities on reducing the number of unbanked, many people have left the banking sector because overdrafts are more expensive than overdrafts.
The new handbook has some shocking new requirements, which we detail below:
- Opt-in for all overdraft products: under Reg E, customers are only required to opt-in to overdraft protection for debit/ATM overdraft protection. However, the handbook requires proof of opt-in for all protection, dramatically expanding the scope
- Banks will have to perform underwriting of customers before extending an overdraft product. The OCC explicitly requires an analysis of income and debt. which provides information for an affordability check.
- Our favorite requirement focuses on “prudent limitations on product costs and usage.” Most importantly, the OCC states that “while permitting appropriate returns, fees should be reasonably correlated to the actual costs of offering, underwriting, and servicing the product as well as associated risks.” The OCC is particularly concerned about “repeated usage of high-cost, short-term loans for longer-term borrowing needs.”
- Critically, the OCC requires that “banks should structure credit terms to reduce the principal balance of the loan over a reasonable period of time.” The worst form of short-term loan offers a customer a choice: pay off the entire balance today, or renew the product for another fee. This method, a favorite of the payday loan industry and copied by many deposit advance products, creates the perfect debt trap. Consumers are unable to pay off the full balance at once, yet banks do not offer an amortizing option. So, people just pay a fee and never get out of debt.
- Finally, the OCC suggest that “banks should consider reporting payment information to credit bureaus.” Currently, the banks tend to report negative information, on a haphazard basis, to Chex Systems. Responsible customers are not able to benefit from on-time repayment. And an alternative credit reporting universe is created, with limited transparency.
Using common sense as our guide, these new rules make a lot of sense. Before lending someone money, make sure they can afford it. Don’t force people into the product: let them have a choice before you start charging them fees. Don’t rip them off with outrageous fees. And provide a repayment method that actually gives someone the chance of getting out of debt.
Overdrafts have become so out of control, that even these new rules will really shake up the overdraft market if banks actually follow the spirit of the requirement. However, I think banks will likely hire expensive law firms to build a robust defense. They will somehow prove that it actually costs $35 for an automated computer algorithm to approve a $6 loan. I just hope the OCC backs up these rules with strict enforcement. And we hope the CFPB builds on this and issues explicit rules that remove the predatory structure of these products.